In the past, a refinancing homeowner cashed-out some of his appreciated equity, refinancing so he could borrow money to spend on consumer goods or other investments. The recent trend has seen a large number of homeowners now adding cash to their mortgages in order to refinance at current low interest rates, in order to pay off their existing mortgage and create the minimum equity required by the new lender.

As a result of the recent drop in home prices, many homeowners are underwater financially with negative equities on their homes. Due to the ultra low 4.75% 30-yr fixed mortgage rates, a third of all borrowers in the nation who refinanced during the fourth quarter of last year put cash into their homes to help pay off the existing mortgage. The percentage dropped during the first quarter of 2010, but Freddie Mac’s chief economist is confident the number of refinancing homeowners that add cash to help pay off their old mortgages will remain high through the rest of this year.

first tuesday take: Freddie Mac’s chief economist claims by adding the cash necessary to pay off the balance of the existing mortgage not funded by the refinancing, the homeowner will get a better return on his money— which makes no sense whatsoever. Using one’s cash reserves to pay down a mortgage that exceeds the value of the property is worse than burying money in the backyard and hoping to find it again twenty years from now.

Investing good money to cover “sunk costs” (bad money, which is unrecoverable under any circumstances, as is the negative equity position in a home) is a fool’s game. This is especially germane for a homeowner who can keep the money in his wallet, add to it by living rent-free for a year and legally walk away from the underwater purchase-assist mortgage without liability.

Having witnessed the housing bubble implosion, homeowners have learned that putting money into any property is never guaranteed as a safe investment — but they now need to realize that putting money into an underwater property is a guaranteed loss.

It is better for the negative-equity homeowner to talk to his real estate agent and make plans to either buy an equivalent home during the next two to three years or to buy one now under contract with an investor. [For more information on cash-in refinancing, see the February 2010 first tuesday article, Homeowners buy-down mortgages with cash-in refinancing.]

Re: “‘Cash-in’ refinancing lets underwater homeowners take advantage of low interest rates” from Los Angeles Times